Corporation Benefits and Deductions
Our firm works with many very small companies, and we are frequently asked if we have a checklist of common deductions and advantages for small corporations. Many of our clients are one owner organizations, usually organized as Subchapter S Corporations that allow significant advantages over being self-employed. Our practice is not limited to only these structures as we advise many other entities such as C corporations and LLCs with more than one owner. The following is a list of frequent topics and a checklist of deductions for these small businesses.
Self-employment or social security taxes
For self-employed persons and LLC members (who are actively engaged in the business), self-employment or social security taxes are a large part of their tax bill. In 2014, the social security tax is 12.4% of the first $117,000 in net income and the Medicare tax is 2.9% on all net income. With an S Corporation, an owner can take part of their income as wages (subject to social security) and the remainder as earnings distributions (not subject to social security). Of course, both wages and net earnings are subject to income taxes. According to the IRS, the wages paid must be similar to the wages you would receive if you were working for someone else at a similar position. Let’s use one example to illustrate how much money can be saved by being a one owner S corporation over a self-employed person. Let’s suppose in both cases that the total net income is $100,000. The self-employed person is going to pay $15,300 in social security and Medicare taxes. If a reasonable salary for the S corporation owner is $32,000, they are going to pay $4,896 in social security and Medicare taxes. This is a savings of $10,404 per year. If you were organized as a single member LLC, you can elect to be “taxed” as an S Corporation, thus saving the self-employment taxes as well.
There are many pension plans out there and one should consult their CPA and a pension consultant before acting, but I would like to explain two easy plans that are often used in lower salary situations. The first is a SEP plan that allows the company to take a deduction for up to 25% of the wages paid to employees. The second is called a Simple IRA. For 2014, this plan allows an employee to withhold up to $12,000 of wages but is not limited to a percentage. There are some matching rules governing what the company must also contribute but these are a bit lengthy and will not be included in this overview.
Taking a look at the two plans, we find in many situations where there is just one owner employee, once the salary is greater than $48,000, a SEP makes more sense. If it is less than $48,000, a Simple IRA makes sense (i.e., $48,000 X 25% = $12,000, whereas a Simple IRA is not limited to a percentage). One planning tool we use when an owner’s spouse or child works for the company and they are trying to get as much as possible in retirement is to do the Simple IRA for them as well. The salary paid must be justified by the work being done. A good example is a husband and wife whose salaries are $13,000 each. They can put a total of $24,000 in a Simple IRA. That’s 92% of income. Remember, Simple IRAs are subject to social security taxes, so the gross must be enough to cover the Simple contribution and social security taxes. There are essentially no (or very low) administrative costs to set up these plans, and people who are 50 years old or older can also make catch-up contributions.
A company is allowed to take a deduction for the business usage of vehicles. One method the IRS allows is to be reimbursed for 56 cents per mile (as of 1/1/14) for your business mileage. This 56 cents per mile covers gas, repairs, depreciation or lease payments, and insurance. The other method is to have the company own or lease the car and pay for the items mentioned above. Of course, any personal mileage would have to be reimbursed or reduced from total expenses. The best method usually depends on the type of car you are driving, how many business miles are driven, and what percentage these miles are to the total miles driven during the year. A large deduction is available for those who purchase an SUV for business use with a gross vehicular weight (GVW) greater than 6000 lbs. by using the "Section 179" deduction discussed below. Once again, there are rules regarding this that should be discussed further before the purchase so that we can help you make the best decision for your situation.
Depreciation - Section 179 Expense
When a company buys equipment, computers, furniture, software, etc. it normally must be depreciated. This depreciation can be anywhere from 3 to 7 years. We usually use a cut off of $300 to expense an item rather than capitalize and depreciate it. But when an item must be capitalized there is a depreciation method called “Section 179 expense” that allows you to take the full depreciation in the first year up to $25,000 (for 2014) worth of assets each year. There are a few other rules regarding this that you should discuss with your CPA. One other item that should be mentioned along these lines deals with fixed assets and supplies brought into the new corporation that were previously owned personally. As long as these items have not already been taken as deductions in a previous year, the company can buy them from the individual at fair market value and start deducting them.
In the past, a home office deduction was difficult to qualify for. Beginning in 1999, these rules relaxed a bit and more people are eligible for this deduction. The thing we like about a corporate deduction (on the 1120S) versus a self-employed deduction (on the 1040) is that the corporation tax forms do not have a separate schedule like the 1040 Schedule 8829-Expenses for Business Use of Your Home. This form 8829 is somewhat of a red flag. But, once you decide you are eligible for the deduction, what method should an incorporated taxpayer use? One method is to pay rent to the owner, but the rent must come back as income to the individual on Schedule E of the 1040. There is an IRS argument that says only mortgage interest, real estate taxes and depreciation are allowed as a deduction against this rent. We already can get a 100% deduction of mortgage interest and real estate taxes on Schedule A. This leaves depreciation, which is also very sticky. If you set up a portion of your house to depreciate as a home office and a few years later sell the property, the IRS can make you recapture the depreciation. What we suggest is that the employee should have a written agreement with the corporation to reimburse him for the costs that are not normally deductible like utilities, homeowners insurance, repairs, maintenance (i.e., cleaning) and homeowners dues. This is a tax-free accountable plan reimbursement to the employee. You must determine what percentage of the house is used exclusively for business compared to the total size of the house and apply that percentage. Things that you do directly to the office (shelves, decorating, supplies, etc.) can be written off 100% without regard to the percentage. New for 2013, there is a simplified method that allows you to deduct $5 per square foot of office space. This alleviates the need to keep all the office receipts and do the tedious computations. Once again, we must remind you there are numerous rules associated with these deductions, so please consult with a CPA.
A change in the law for 2003 now allows owner’s health insurance to be 100% deductible. Previously, health insurance was only partially deductible for the owners. Laws for S Corporations owners are tricky, so be sure to discuss with us.
Meals and Entertainment
A 50% deduction is allowed for meals and entertainment with clients, vendors, etc. Be sure you know your substantiation requirements.
Such items as telephones, car phones, internet connections, pagers, and web sites can be written off if they are used for business. If the internet, pagers or car phones are used partly for business and partly for personal reasons, you should only take a reasonable percentage. Also, if you have only one phone in your house, the monthly charge for that line is not deductible, only the long distance calls on it. A second phone line used solely for business is totally deductible.
A person who is self-employed and files an individual income tax return with a Schedule C is 200%-400% more likely to get audited than an individual with an S Corporation.
With a self-employed person and many times with a partnership/LLC, you are only required to produce a profit and loss statement (i.e. revenues minus expenses ) to complete the tax return. A corporation must be able to complete a balance sheet and profit and loss statement. There are various methods used to keep up with bookkeeping and we can help with any one. Some people prefer to do it the old fashioned way with handwritten ledgers and spreadsheets. Others who have computer experience and some bookkeeping knowledge use software programs such as Quickbooks. We find the most successful way is to have us do the bookkeeping monthly or quarterly using our system. Often it is not much more expensive than what we would charge at the year-end because we do not have to go back and correct mistakes, etc. It also allows you to have more contact with us, and we can constantly give you guidance and suggestions for deductions and improvements. But we do support Quickbooks and Peachtree accounting systems, to name a few.
When you are incorporated and have a profit, you are going to have payroll. There are many forms to fill out to get started. There are also many laws and forms once you are in motion. If you miss a deadline, penalties and interest can get expensive. We can help you with payroll. Occasionally, when we cannot set it up to be convenient for the both of us, we may refer a payroll service such as ADP or Paychex. We can discuss your options.
Other: Here are some other typical deductions that need no explanation:
This is not to say that an S Corporation is the only answer. Many times a C Corporation, Partnership or LLC can be better in certain situations, and we know the ins and outs. This summary covers a lot of ground, and as mentioned earlier, these things should be discussed with a CPA. Hopefully it is us.
- Bank charges
- Office supplies
- Clients gifts
- Printing and stationery
- Professional education
- Professional dues and subscriptions
- Computer supplies and services
- Travel (airfare, hotel and rental car)
- Postage and shipping
- Legal and accounting
Scott A. Dewey, CPA PA